Trading Ideas: Mechanical or Discretionary?

I have already discussed the importance of having a good trading plan before sitting down and trading.

Essentially, the objective of the trading plan is to minimize the decisions that have to be made since, especially during intraday trading, leaving too many decisions open to subjectivity and the emotions of the moment can lead us to make mistakes.

The essence of the trading plan is the trading system that we are going to use. In it, we will have defined what conditions should be set when we enter the market, what we will do when these conditions occur, and when we should consider closing the trade and taking the profits off the table. Alternatively, at which point we should cut our losses.

But it is important to note that within the broad spectrum of trading systems, there are two clearly differentiated methodologies that involve radically different trading, and therefore require both technical and subjective analysis – automatic systems vs. discretionary systems.

Mechanical trading systems

Actually, these types of trading systems are given different names: automatic, mechanical, algorithmic, systematic, etc. The idea is very clear: it is a system that almost completely limits the boundaries of the trading platform, and therefore could be executed without major problems by a computer programmed automatically for it.

They are trading systems tightly linked to statistical data, and require the trader to have an iron discipline in order to execute everything dictated by the system, regardless of the emotions that come into play.

If the system says that you should execute a particular type of trade when volatility reaches a certain level ,or when a stock hits a certain share price, you must make 100% of those trades.

The main problem with these systems is that, based on past statistics, they can go through drawdown stages in which the system loses, and it is normal not to detect this situation until the hole in your account is considerable. These situations can also be emotionally complex.

Discretionary trading systems

At the other extreme, we find discretionary systems, which, although they establish a series of basic rules to determine in which situations market entry can be valued, leave the final decision to enter or not the trade up to the trader, who is reading the market in real time.

With these systems, a market reading capacity is much higher than can be obtained using mechanical systems, but it has the great disadvantage of requiring a greater subjectivity on the part of the trader, and that implies in turn having greater emotional self-control.

It is much more demanding and requires more training time and screen hours to trade with a discretionary system, but also generates capabilities that allow the trader to operate different markets and financial products without major problem.

So which type of strategy should you employ? I recommend starting out with mechanical systems at the outset, and once you have gained sufficient experience, graduating to discretionary trading systems. Let us know what system you’re using.

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